On
August 22, 2008, the IRS released Chief Counsel Advice (CCA)
200834019, addressing whether a retailer could use the
recurring-item exception of Sec. 461(h)(3) to treat its cash
rebate liability as incurred in the year of the sale of the
rebate-eligible product.

In a nutshell, the Office of
Chief Counsel concluded that the taxpayer may not do so,
because the rebate liability was not fixed until the customer
complied with the rebate requirements and thus did not meet
the required all-events test. As a result, the question of the
recurring-item exception's applicability was moot.

Incidentally, this CCA is apparently related to CCA
200826006, in which the IRS advised that a retailer's method
of accounting for its cash rebate liabilities was not
permitted under the regulations. In that case, the taxpayer
did not record the full purchase price as income at the time
of the sale, even though it received full price at that time.
Instead, it reduced its gross receipts by the amount of its
estimated rebate payment. Later, if a particular rebate
expired, it reversed the prior reduction from gross receipts
by bringing back into income the amount of its previously
estimated rebate payment. The Service stated that this method
did not follow Regs. Sec. 1.461-4(g)(3), which provides that
economic performance for rebates occurs as payment is made to
the person to whom the liability is owed.

Note: Various sources differ as to whether the
economic performance rules are part of the all-events test.
Even the IRS seems to treat it both ways: In Publication 538,
Accounting Periods and Methods, it seems to view
economic performance as separate from the all-events test,
whereas in CCA 200834019 it treats economic performance as a
third prong in the allevents test. Practically speaking, there
is no real difference, since Sec. 461(h)(1) provides that
"the all events test shall not be treated as met any
earlier than when economic performance with respect to such
item occurs." Nevertheless, for purposes of this
discussion, the all-events test will be treated as a two-prong
test.

Background

An accrual-basis taxpayer is
generally entitled to deduct an item in a particular year
(assuming it is otherwise deductible in the first place) only to
the extent that:

It meets the all-events test (i.e., all the events have
occurred that establish the fact of the liability, and the
amount of the liability can be determined with reasonable
accuracy); and

Economic performance has
occurred with respect to the liability.

In
addition, Regs. Sec. 1.461-5(b)(1) provides a limited
exception to the economic performance rules, allowing
taxpayers who adopt it to accelerate the time at which
economic performance is deemed met. This recurring-item
exception allows a taxpayer to treat a liability as incurred
for a tax year if:

At the end of the tax year, all events have occurred
that establish the fact of the liability and the amount can
be determined with reasonable accuracy;

Economic performance occurs on or before the earlier of
(a) the date that the taxpayer files a return (including
extensions) for the tax year or (b) the fifteenth day of the
ninth calendar month after the close of the tax year;

The liability is recurring in nature; and

Either the amount of the liability is not material, or
accrual of the liability in the tax year results in better
matching of the liability against the income to which it
relates than would result from accrual of the liability in
the tax year in which economic performance occurs.

Regs. Sec. 1.461-5(b)(5)(ii) provides that in the case of
a liability for rebates, the matching requirement of the
recurringitem exception is deemed satisfied.

Note, however,
that this exception to the usual economic performance rules
does not override the all-events test and does not accelerate
the deduction for items that are not fixed and determinable.
Unfortunately, as in the case of the taxpayer in CCA
200834019, taxpayers often misunderstand this aspect of the
recurring-item exception.

Details of CCA
200834019

The chief counsel advice addressed the case of a
consumer products retailer using the accrual method of
accounting. Like many retailers, the taxpayer had a cash rebate
program that involved issuing cash payments to buyers that met
specified conditions. Under the program, a thirdparty
administrator handled the taxpayer's rebate plan, processing
rebate claims and issuing checks if the purchasers met all
applicable conditions.

The conditions of the rebate were as
follows: After purchasing the product, the buyer would have
to:

Fill
out the rebate form provided when the merchandise was
purchased;

Cut out and attach a copy of the
UPC code from the merchandise;

Attach a copy
of the sales receipt; and

Send these items by
mail to the thirdparty administrator within 30 days of the
purchase date.

If the customer timely complied
with the specified conditions, the third-party administrator
would issue the customer a check in the amount of the rebate
offer. The third-party administrator would wait to issue the
check until at least 30 days had passed from the purchase date
to ensure that the customer had not returned the merchandise,
and the check was often issued several months after the rebate
request was properly submitted. In addition, based on its
experience, the taxpayer estimated that it only paid or redeemed
a percentage of the total rebate offers.

Query from the field to the Office of Chief Counsel:
The IRS field agent examining the taxpayer asked the
Office of Chief Counsel for advice on whether all the events
occurred that establish the fact of the taxpayer's liability
for the cash rebates at the time of the issuance of the offers
(at the time of the sale of a product), allowing it to treat
the liability as incurred in the year of issuance, as long as
the rebates were paid within the period permitted under the
recurring-item exception.

Chief counsel's opinion: The Office of Chief
Counsel began its analysis by discussing the all-events and
economic performance tests (which it collectively labeled the
"all-events test"). It then moved into the issue of
when the rebate liability became fixed, which was a
prerequisite to the use of the recurring-item exception.

Citing several revenue rulings, as well as General
Dynamics Corp., 481 U.S. 239 (1987), and Hughes
Properties, Inc., 476 U.S. 593 (1986), the IRS pointed
out that the rebate liability was not unconditionally due
until the customer mailed a properly completed rebate form
with attachments. It based its rationale on the premise that
the taxpayer's situation in the CCA was similar to that in
General Dynamics, where the liabilities associated
with the taxpayer's self-insured medical plan were not fixed
until the employee-patient submitted properly completed claim
forms.

Moreover, the Service distinguished the
taxpayer's situation in the CCA from that of the Nevada casino
operator in Hughes Properties, in which the taxpayer
was required by state law to pay out a jackpot based on
amounts gambled in progressive slot machines and was required
to keep a cash reserve sufficient to pay the guaranteed
jackpots when won. Because the amount of the casino's
liability was fixed by the slot machine payout indicators, the
last event necessary to fix liability was the last play of the
slot machine before the end of the casino's tax year.

Conclusion

Ultimately, the IRS found the recurring-
item exception question to be moot because the rebate liability
was not fixed until the customer complied with the rebate
requirements. Because the liability was not fixed, the taxpayer
did not meet the all-events test with respect to that liability
and was not entitled to a deduction for the estimated rebate
liability at year end.

Even though the CCA may not be cited
or used as precedent, it does persuasively rely on
authoritative Supreme Court case law. CCA 200834019
demonstrates the importance of a careful analysis of the facts
and circumstances associated with any potential deductions of
year-end liabilities.

EditorNotes

Michael Koppel is with Gray, Gray &
Gray, LLP, in Westwood, MA.

The Tax Adviser would
like to acknowledge the special contribution to the December
Tax Clinic of Singer Lewak LLP; Mark G. Cook, tax partner in
the Irvine, CA, office; and Steve Cupingood, the partner in
charge of that firm's tax practice.

For additional information about these items,
contact Mr. Koppel at (781) 407-0300 or mkoppel@gggcpas.com.

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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